Till 31.08.2016 and with effect from 1.9.2016, the Government dues have lost priority of its tax dues against the banks or financial institutions secured creditors (hereinafter referred to as ‘secured creditors’) since the Recovery of Debts and Bankruptcy Act, 1993 and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 were amended by inserting sections 31B and section 26E in respective Acts on 1st September 2016. The section 31B of the Debts and Bankruptcy Act, 1993 came in force from 1st September 2016 and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 came in force from 24th January 2020.

Several High Courts, except Rajasthan High Court in GMG Engineers & Contractor Pvt. Ltd., VS State of Rajasthan S.B. Civil Writ Petition No.6872/2017 dt 5th July, 2017, have taken view interpreting the said amendments to have effect of priority of secured creditors over Government dues in respect of taxes such as Income Tax Act 1961, Customs Act 1962, Central Excise Act 1944, Finance Tax Act 1994, and other State Tax Laws which provided for first charge for their respective dues under their laws.

The details of the cases in which the High Courts have held priority of banks or financial secured creditors are as follows:

1 Full Bench decision of the Madras High Court in Assistant Commissioner Vs. Indian Overseas Bank & Ors. AIR 2017 Madras 67 dt 10th Nov.2016;
2 Axis Bank Limited vs State of Maharashtra Writ Petition No 1796 of 2015 dt 7th March, 2017; 2017 (3) AIR(Bom) R 305
3 Bank of Baroda Vs. Commissioner of Sales Tax, M.P., Indore & Anr. and by the High Court of Madhya Pradesh (2018) 55 GSTR210 (MP )dt 31st Jan,2018;
4 Bank Of Baroda Through Its … vs State Of Gujarat R/SPECIAL CIVIL APPLICATION NO. 12995 of 2018 dt 16th September, 2019;
5 Kalupur Commercial Co-Operative … vs State Of Gujarat R/SPECIAL CIVIL APPLICATION NO. 17891 of 2018 dt 23rd September, 2019;
6 ASREC (India) Limited vs State of Maharashtra Writ Petition No. 1039 of 2017 dt 13th Dec 2019; 2020 (2) BCR 243
7 Cosmos Co-operative Bank Vs. State of Maharashtra and others, 2019 SCC OnLine Bom 9527
8 Medineutrina Pvt. Ltd. (Company) Through its Director – Dilipkumar Versus District Industries Centre (D.I.C.), Udyog Bhavan, Nagpur & Others Writ Petition No. 7971 of 2019 18th Feb 2021 ;

In GMG Engineers & Contractor Pvt. Ltd., VS State of Rajasthan S.B. Civil Writ Petition No.6872/2017 in judgment dt 5th July, 2017, the Rajasthan High Court took a view that Section 26E of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 gives priority to the secured creditor but it cannot be construed to nullify the statutory first charge.

Similar view is taken by Bombay High Court , Nagpur Bench, in Medineutrina Pvt. Ltd. (Company) Through its Director – Dilipkumar Versus District Industries Centre (D.I.C.), Udyog Bhavan, Nagpur & Others Writ Petition No. 7971 of 2019 18th Feb 2021, concurring with the earlier decisions of the Courts that secured creditors have priority over Government dues , however it held that :

  • The dues of the Bank as a secured creditor, in light of the language of Section 26-E of the SARFAESI Act will have priority, but that does not have the effect of wiping out the dues payable under any Central/State/Local Act, where, for the recovery of such dues, a first charge has been created When a statutory charge is created on the property, the same would go with the property and would follow the property, in whosoever’s hands the property goes.
  • The notice of such a statutory charge on the property, is always presumed in law, to one and all and none can claim ignorance of the same. A successful auction purchaser, thus would hold the property, upon which a statutory charge has been created, subject to such charge and the property would thus continue to be liable for any statutory charges created upon it
  • The prioritygiven in Section 26-E of the SARFAESI Act, to the Banks, which is a secured creditor, would only mean that it is first in queue for recovery of its debts by sale of the property, the other creditors being relegated to second place and so on in the order of their preferences, as per law and contract, if any, as the case may be.
  • The dues under Section 37(1) of the MVAT Act, 2002 would also be recoverable by sale of the property, and that puts a liability upon the auction purchaser, who, in case he wants an encumbrance free title, will have to clear such dues. Thus the purchase of the property holds it with all its rights, obligations and liabilities, whatsoever they may be, which would include, all dues, impositions, restrictions as may have been imposed upon the same and consequent to acquiring title to the property.
  • It duty of the auction purchaser, before bidding for the same, to make inquiries about the impositions upon the property, so that he can have it free of any encumbrances. After acquiring title to the property, the auction purchaser cannot be heard to say that he will have the rights associated with the property and not the liabilities.
  • The obligation to make reasonable enquiries about the encumbrances and liabilities and to include such liabilities in the notice inviting the bids, is on secured creditor or if that is not done, to include the tax liabilities in the reserve price, fixed for sale of the security interest, so that the encumbrances can be taken care of.
  • The bank is bound to disclose such encumbrances in advertisement inviting bids. The secured creditor is also bound to make enquires about any encumbrances attached to the property under sale and disclose to prospective buyer.

Hence, as on today, though the secured creditor being bank can appropriate sale proceeds first in priority, the obligation to discharge tax dues under respective Acts shall survive and it will for the auction purchaser or secured creditors who will be responsible for such discharge of tax dues.

However, the decision in Medineutrina Pvt. Ltd.(supra) is under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 , the question is whether the ratio will be applicable to the recovery under the Recovery of Debts and Bankruptcy Act, 1993, since the wordings of section 31B and section 26E are different.

One more clarification is needed that the priority is given to secured creditors under respective Acts , shall always mean any bank or financial institution or any consortium or group of banks or financial institutions as secured creditors and not any private parties which has advanced any funds against security since the definition of the secured creditors has referred to secured creditors as banks and such parties on behalf of banks.

History:

Statutory Charge:

The concept of priority of Crown debts over secured was considered in Dena Bank vs Bhikhabhai Prabhudas Parekh & Co[ 2000 (5) SCC 694] and Apex Court held that if statute provides for priority of its dues , it shall prevail. Otherwise, crown debts have priority only over unsecured creditors and not over secured creditors.

In State Of Bank Bikaner & Jaipur Vs. National Iron & Steel Rolling Corporation And Others 1995 Scc (2) 19 Apex Court held that the Section 11- AAAA of the Rajasthan Sales Tax Act creates a first charge on the property, thus clearly giving priority to the statutory charge over all other charges on the property including a mortgage.

When and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 came in force , several banks contended that banks will have priority over the states’ first charge because of non obstante clause contained in the Act.

The controversy was set at rest in favour of States in the judgment of the Apex Court in Central Bank Of India vs State Of Kerala & Ors 2009 (4) SCC 94, holding that the DRT Act and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 does not provide for first charge in respect of secured debts due to Banks and hence the provisions of State Sales Tax Laws creating first charge will prevail over the dues recoverable from debtors.

It is settled position in law that under Income Tax Act 1961, there is no provision in the Act which provide for priority of Income Dues over debts due to secured creditors.

[ Tax Recovery Officer vs Bank of India and 2 Ors,High Court Of Gujarat At Ahmadabad Special Civil Application No. 13196 Of 2008 And Special Civil Application No. 888 Of 2009, | Karnataka State Industrial Investment Development Corporation Ltd., Versus Commissioner of Income-Tax, Mangalore & Another 2013 AIR(Kar) 104 and, Stock Exchange, Bombay vs. V.S.Kandalgaonkar, in CIVIL APPEAL NO.4354 of 2003 Supreme Court]

Under the Central Excise Act 1944 Section 11E. provides for first charge for any amount of duty, penalty, interest, or any other sum payable subject to Section 529A of Companies Act, Recovery of Debts Due to Banks and the Financial Institutions Act, 1993 (51 of 1993) and the Securitisation and Reconstruction of Financial Assets and the Enforcement of Security Interest Act, 2002, (54 of 2002).

Under the Customs Act 1962 section 142A, and under Service Tax Law (Finance Act 1994) section 88 , provides for first charge similar to one in under Section 11E of Central Excise Act 1944.

After the amendments in the Recovery of Debts and Bankruptcy Act, 1993 and Securitisation and Reconstruction of Financial Assets and the Enforcement of Security Interest Act, 2002, the provisions of aforesaid tax statutes providing for first charges is effectively nullified and banks as secured creditors will have priority over Government dues in respect of taxes.

Hence, to sum up the legal position as emerges from statutory provisions and judicial pronouncements is that the Secured Creditors being banks shall have priority over Government tax dues, however , in respect of recovery of dues under Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 but tax liability to be discharged by auction purchaser. Under, the Recovery of Debts and Bankruptcy Act, 1993 there is judgment that decided that statutory charge continues and till then issue remains open.

INSOLVENCY AND BANKRUPTCY CODE 2016 READ WITH COMPANIES ACT 2013

Under the IBC, in case of default by debtors when Resolution Professional (RP) is appointed by Tribunal, claims are invited from creditors, financial and operational creditors. The statutory dues are classifiable as operational creditors.The Revenue authorities are obliged to file its claims before the RP. The bids will be invited from Resolution Applicant and rival Applicants file their plans. If a plan is approved by Committee of Creditors , the same shall be put before the Tribunal and on approval of the plan , the creditors will be paid as per the plan approved. Not infrequently, statutory dues is provided negligible amounts and revenue has no recourse , except appeal, to accept the amount provided in the Resolution Plan,As per judgment of Apex Court dt 13.04.2021, in the case of Ghanshyam Mishra all liabilities not provided in the Resolution Plan shall get extinguished in view of amendment in section 31 to the effect that it shall be binding , inter alia, on the Government. Hence, no further recovery beyond what is provided in Resolution Plan can be pursued.

However, when the Resolution Plan fails for what ever reason or such plan is found to be not viable, the Debtor will be liquidated and the priority of the Revenue is almost at bottom of all creditors and above unsecured creditors.

Section 53(1) of the Code lays down the following order of priority in which the proceeds from the sale of the liquidation assets shall be distributed:

1. IRP costs and liquidation costs

2. Workmen’s due for the period of twenty-four months preceding the liquidation commencement date and debts owed to a Secured Creditor

3. Wages and any unpaid dues owed to employees other than workmen

4. Financial debts owed to unsecured creditors

5. Any amount due to the Central Government and the State Government including the amount to be received on account of the Consolidated Fund of India and the Consolidated Fund of a State, if any, in respect of the whole or any part of the period of two years preceding the liquidation commencement date

6. Any remaining debts and dues

7. Preference shareholders, if any

8. Equity shareholders or partners, as the case may be.

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